Thoughts on the “Great Rotation”

By Marc Chandler, Global Head of Currency Strategy, Brown Brothers Harriman

Reports indicating that Americans have invested more in equity funds here in 2013 than they did all last year have given rise to talk of the “Great Rotation”. The idea is that Americans are selling fixed income investments bought during the financial crisis and now buying shares.

We are less sanguine. There is a third asset class that needs to be integrated into the analysis: cash. After surveying the data and various reports, it looks to us that the flows into equities is not coming out of fixed income but rather money market funds and deposits.

At the end of last year, perhaps spooked by the pending fiscal cliff and policy paralysis, many investors boosted cash (money market and deposits) holdings. One estimate had cash holdings rising by about $350 bln in the Nov-Dec period and about $165 bln has flowed out since the start of the year.

Through last week, equity funds (counting ETFs) saw an inflow of around $70 bln (compared with $23 bln in all of 2012). The $30 bln inflows being reported by bond funds is a major argument against the “Great Rotation”, though this is a bit off the pace seen last year ($40 bln inflows during the same period).

Drilling down a bit deeper may offer greater insight into what investor are doing. Of the $70 bln that went into equity funds (and ETFs), about 40% went international/global funds, which is more than half they took in all last year. Among bonds, about 40% also went to emerging markets, which is roughly tracking last year’s record pace.

Lipper reported that in the week ending Feb 6, equity funds (mutual funds and ETFs) saw $6.1 bln in new inflows. It was the seventh consecutive week of inflows. Of this sum, $2 bln as in ETFs. However, Lipper notes that the SPDR S&P 500 ETF fell from top position the previous week to last on the back of $3 bln of redemptions. The iShares Russell 2000 index was on top with $700 mln inflow, followed by ishares Dow Jones Real Estate ETF, which took in $600 mln.

Traditional open-ended equity mutual funds saw inflows of $4.1 bln. According to Lipper data, the 5-week inflow of almost $25 bln is the largest inflow for such a period since the beginning of Q2 2000. Domestic funds, led by large cap, drew $1.1 bln. Global and international funds reported inflows of $3.1 bln. Emerging market funds saw $1.8 bln inflows. Lipper notes this was the fifth consecutive week that emerging market funds drew more than $1 bln.

Many Asian bourses have reported strong inflows (greater than last year) thus far this year. In terms of the biggest gain from the year ago period, investors have bought almost $1.1 bln of Indonesian shares, which represents. In terms of dollar amount, Japan of course is the largest bourse and in play, given the yen’s weakness. Foreigners have bought about $14.1 bln of Japanese shares this year, which is 135% above the year ago pace. India is also a large beneficiary of foreign purchases. The $7.6 bln that has flows in represents a 725 increase from a year ago.

On the other side, South Korea is a significant exception. Foreign investors have sold about $1.5 bln of Korean equities. The appreciation of the won against the yen appears to have contributed to the profit-taking. Taiwan and Thailand have seen inflows ($1.6 bln and $22 mln respectively), but are well off last year’s pace.

That said, we note that the Korea’s Kospi appears to have bottomed at the second half of last week. The 2.5% bounce has brought it to a trend line drawn off the Jan 3 and Jan 23 highs. The next target is near 1985 (closed near 1976 today). Longer-term, a recovery could see 2040-2050. The technical condition looks favorable as the RSI has turned higher and the MACDs are crossing.

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Marc Chandler

Marc Chandler

Marc Chandler has been covering the global capital markets in one fashion or another for nearly 25 years, working at economic consulting firms and global investment banks. Chandler attended North Central College for undergraduate. He holds masters degrees from Northern Illinois University and University of Pittsburgh in American History and International Political Economy. Currently Chandler teaches at New York University Center for Global Affairss, where he is an associate professor.

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  • pragcapfan

    I don’t understand how this data is calculated. As Hussman says, the amount of cash and stocks in total are constant unless companies are issuing new stock or retiring old stock. If I trade cash for stock, someone else must have traded stock for cash.

  • Boston Larry

    Marc, you said: “According to Lipper data, the 5-week inflow of almost $25 bln is the largest inflow for such a period since the beginning of Q2 2000.” Is it a coincidence that March-April of 2000 represented a significant market top after which followed a decline of more than 20%. Surely such a scenario is impossible this year, or is it? Thanks for a very good article.

  • http://www.fanbrowser.com/ Cowpoke

    Samsung is Kicking Ass & taking names “Apple” and the south Korean mtk is selling and investors are instead buying JAPANESE in which they and China are squabbling?
    This is NOT GOOD, NO WAY.

  • Christian

    I would also refer to Hussman’s piece on the so-called “Great Rotation”

    The newest iteration of the bullish case is the idea of a “great rotation” from bonds and cash to stocks, as if the outstanding quantity of each is not held by someone at every point in time. The head of a “too big to fail” investment firm argued last week that stocks are “underowned” – as if every share of stock presently in existence is not actually owned by someone. To assert that stocks can be “underowned” seems to reflect either a misunderstanding of how markets work, or a desire to distribute overvalued institutional holdings onto the unwashed muppets. Likewise, the idea of a “rotation” out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade. Similarly, to “move cash into the market” requires a seller of stock who becomes the new holder of said cash.

  • Hoffa

    I am also confused by this. The only way I can make sence of it is by order flow, if the buyer or seller is taking the initiative for the trade. However, the stock of each asset class must be unchanged by trades. The value of each stock can change, however that can happen without any trades taking place.

  • p fitzimon

    I agree. I’ve never really understood the money flow concept. However, Barron’s defines a net positive flow if more money enters the exchange on upticks as opposed to downticks. Currently, the upticks are winning as Chandler reports.

  • jaymaster

    Christian,

    I agree with most of what you said, except for this:

    “Likewise, the idea of a “rotation” out of bonds and into stocks begs the question of who will buy the bonds and sell the stocks, as someone must be on the other side of that trade”

    When bonds mature, they basically disappear, and the previous owner receives cash. Now they have to decide whether to keep the cash, reinvest it in another bond, or stocks, spend it on something real, etc.

    It’s also possible that the entity buying a bond on the open market created the money out of thin air….

  • Hans

    I do it every 5000 miles…

  • Christian

    Hi Jaymaster, thanks for your reply and interesting comments!

    The way I understand it, even when a bond matures and the previous owner receives cash it should only have an effect on the flow in and out of bonds.

    If the previous bond owner decides to use this cash to buy stocks, the stock will just change hands. Because the money the previous bond owner puts into stocks has to have a counterpart who is actually selling the stocks. Hence, the flow in and out of stocks is neutral.

    PS.
    As for buying bond ont the open market with money creasted out of thin air – I believe there still has to be a counterpart selling the bond. Thus, the effect should be neutral.

    PPS.
    I agree with the notion regarding bonds maturing (or bonds bought in the first hand market with money created out of thin air). However, I do not think this is a reflection about asset rotation, but instead it is a reflection regarding the total amount of debt issued. Thus, what many commentators has argued as great rotation into bonds in recent years is only a result of increased debt through the bond market.